IMF urges Canada to stay the course

Canada’s new government should stay the deficit-cutting course outlined in the March budget and leave it to the Bank of Canada to keep stimulating the economy with low interest rates, the IMF advised in a forecast update Tuesday for countries in the Western Hemisphere.

“The policy mix for this year is appropriately set to entail a continued simulative stance of monetary policy, as fiscal policy begins a path from extraordinary stimulus to medium-term budget balance,” the global lender of last resort said.

“On fiscal policy, both federal and provincial governments are rightly focussed on bringing budgets back toward balance,” it said. “Meanwhile, monetary policy is likely to remain accommodative, in view of the soft world recovery and the environment of global monetary ease.”

The main external threat to the continued economic growth in Canada is the sluggishness of the U.S. recovery while the high debt load of Canadian households poses an added domestic risk, it said.

While it noted that the federal government has introduced measures to rein in household debt, it warned it to remain vigilant and be ready to take “further steps … if needed.”

The IMF, meanwhile, applauded the government and Bank of Canada for their successful rescue of the economy from recession and held up the Canadian banking system as an example for other countries to emulate.

“Canada’s financial system displayed remarkable stability during the global turbulence,” it said, noting that no financial institution failed or required injections of public money.

Key factors behind this relatively strong performance included:

Sound supervision and regulation which met best practices in many dimensions.

Stringent capital requirements.

Conservative balance-sheet structures with banks having a profitable and stable domestic retail market, and, like their customers, exhibiting low risk tolerance and having had smaller exposure to ‘toxic’ assets than many international peers.

A proactive response to the financial crisis by authorities who quickly reacted by expanding liquidity facilities, providing liability guarantees, and purchasing mortgage-backed securities.

More recently, and amid concerns of household indebtedness, new rules to curb mortgage credit which are consistent with the best practices for stable housing finance systems.

Regulation reviews by federal authorities every five years to keep pace with financial innovation with the next review to be completed in 2012.

Conservative residential mortgage markets with only five per cent of mortgages being subprime compared with 25 per cent in the U.S. and only 30 per cent being securitized compared with 60 per cent in the U.S., and with all effectively being government guaranteed.

The non-deductibility of mortgage interest, again unlike in the U.S., encouraging borrowers to repay quickly.

The IMF also noted that despite Canada’s close ties to the U.S., its recovery from the global crisis has, in contrast, been relatively swift, with the economy recovering all the ground lost by the spring of last year.

While the report suggests the resilience of Canada’s financial system helped, it credited the response of the government and central bank as being key to the rapid turnaround in activity.

“On the fiscal side, the government launched a large and well-targeted stimulus … including measures targeted at credit, housing, and labour markets,” it noted. “Likewise, monetary policy has remained highly accommodative, and interest rates have been unchanged following a small rate increase in mid-2010.”

Still, it forecasts that overall economic growth will slow this year to 2.8 per cent, similar to what the Bank of Canada is projecting, from 3.1 per cent last year.

“Domestic demand growth is projected to slow somewhat as household balance sheets are stretched and the fiscal stimulus is withdrawn,” it explained. “Markets expect that monetary policy will remain accommodative for an extended period of time, and that it will reach only gradually a neutral stance by end-2012.

While rising oil prices would benefit Canada’s trade balance, that would be largely offset by the their dampening impact on the global economy and by a stronger Canadian dollar.

The risk of a double–dip recession in the United States, meanwhile, has receded, but Europe remains vulnerable and new risks have emerged, it also said, citing rising oil prices which would slow global growth and the record high U.S. government debt which could push up interest rates there and globally.